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The Leverage Used For Canadian Real Estate Might Be Higher Than We Think

People often boast of the quality lending standards that support Canadian real estate. Every now and then, lawyer and investor Joey Evans reminds us that’s not really the case. He recently posted a great example on his Twitter account, highlighting a Toronto home. The mansion, located in the City of Toronto, had mortgage debt over 3x the appraised value. That home was so far underwater, you would need Argo just to see it.

Let’s Focus On The Leverage

Today we’re just going to focus on the leverage obtained in the private lending space against a home. People make bad investment decisions, it’s not that big of a deal. So I’m going to gloss over who the owner and lenders were, as well as the address of the property. Although the property itself has itself gone viral as the “probably toxic” mansion in Eastern Toronto. Today we’ll just be focusing on what was borrowed against this home.

Sold For $3.45 Million, With $10.5 Million In Mortgages?

The property, sold through court order, was sold for just a fraction of the mortgages on the home. Court documents show the property was appraised for $3.2 million, and sold for $3.45 million. A total win, right? Not exactly, when you find out there was three mortgages attached to the property.

The three mortgages add up to multiples of the sold price. Court documents show the first lender was owed $2,534,582, as of May 28, 2018. The second lender was owed $1,164,755 as of June 11, 2018. The third lender was owed $6,800,000, as of May 14, 2018. We’ll save you the time of pulling out your calculator, it adds up to $10,499,338 – about $7 million less than was owed. What kind of collateral do you need to put up to get a loan-to-value (LTV) of 328%? The court docs don’t state there was anything else.

There’s a lot to take away here, but Evans boiled it down to three key points. First, lenders were willing to go into a deal that resulted in an LTV substantially higher than 100%. Actually, they lent multiples on the property, which he called an “unprecedented phenomenon.” Second, there are underwater homeowners in Toronto, despite the popular myth that’s perpetuated. Third, these are private lenders, so the debt and default is not recorded on any government stat. The last point is the most interesting, if you consider the rapid growth of the largely unregulated private lending space.

Toronto Is Increasingly Turning To Private Mortgages

The unregulated lending space is booming in Greater Toronto. The first quarter of 2018 saw an estimated $2.09 billion of private mortgages, up 2.95% from the year before. Since 2017, each quarter has averaged at least $2 billion in new originations. This becomes even more interesting with the huge drop in real estate sales. As originations decline at traditional lenders, more Toronto buyers are going private. No one knows what the LTV, or default rates are on these loans, but the lenders themselves.

Greater Toronto Private Lender Mortgage Originations By Quarter

The dollar value of private mortgage originations per quarter.

Source: Bank of Canada. Better Dwelling.

The private mortgage space used to be a small niche that most people ignored. I recall an agent once telling me “who cares if someone wants to take out a massive loan they don’t qualify for?” After all, they’ll become distressed and sell that property in a few days, before they default. No one gets hurt, and they might even make a profit.

That’s all fine and dandy when prices expand, but that’s not the case when liquidity dries up. Nearly 1 in 10 mortgage dollars borrowed in Greater Toronto are now from private lenders. There’s no regulations on the LTV, and they’re paying eye-watering interest rates. The recent buyers are no longer just a few people with a high risk tolerance, they’re the comps that determines your home price.

55 Comments

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Not too far off from the article you folks posted where a Big Six lender had a mortgage with an LTV higher than 100%. I’d like to know what the government’s logic is behind allowing these mortgages in any case.

I believe that’ the problem, these are off book. How did some of these private lenders not run background checks on the underlying assets to see if there was any other debt? Something smells really fishy.

Bonkers. Private lending is going to be multiples worse than the sub prime problem in the US since it was incubated to ‘finance professionals’ and as we’re seeing there are layers and layers of debt. Private lenders can’t mitigate risk as they aren’t savvy enough nor have a long-term model; there are no puts/calls/options/futures/10-yr bonds behind the scenes to limit the downside (fyi: I have no real idea what those things are…not a financial professional!). if anything, private lenders are more reckless and putting everything they have on the line to prop up other bad bets. The guys getting whooped in brampton is only the beginning of the sort of turmoil that is going to bubble to the top. There will be blood, literally. Tick tock.

These ‘dark market’ lenders have borrowed the money that they lend, from someone else. When the mortgage goes sour, these secondary lenders are on the hook. The obligations of these secondary lenders can not be met, and a third layer goes under. And so on and so on.

A default on $10 million is quite a chunk of change to take out of the system. How deep, and how many lenders, will this impact?

There may not have been enough assets to back the original over-leveraged mortgage loan, but somewhere back through the lending-borrowing-leveraged chain, are there real money and real assets that have been compromised? Is there someone, somewhere on the chain, that is out millions of dollars of real, not leveraged, money?

The question for the economy is, what did this over-leveraged mortgagee use the excess borrowed money for? Was this person, in fact, just part of the huge ‘leverage’ chain, using the over-leveraged mortgage money to, in turn, lend out to other people who were over-leveraged?

Like one long line of stacked dominoes, when one collapses it just goes up and down the entire over-leveraged line.

Just maybe, there ARE no real, tangible assets in the chain, just a circle of over-leveraged loans all circling back, like a snake eating its tail.

Over-leveraged borrowers lending to over-leveraged borrowers lending to over-leveraged borrowers until the money comes back on itself.

Big question is. How many of these private lenders are using their own real (or pooled ) money vs leveraging existing assets (HELOCS) to get into the banking space? The only one I know borrows money against his properties at 4% and then lends it back out at 12-18%.

If most (or even a big enough share) of the lenders are opperating like this, than it will not be long before the defaults do work their way back to the big banks. Time will tell

On a side note……… your new comment policy discriminates against rednecks…………. I kid, dont block me

Well the question is always where are these families getting the cash to lend to private lenders? Mom and pop, HELOCs, probably a very few people that are looking to professionally diversify. Every week I get an offer on my LinkedIn for a great opportunity to become a lender.

I studied business model of one of the big private lenders. You probably be surprised but they even go public, issue stock and bonds and people buy those. Also because this business is booming now they can issue additional stock shares out of thin air because even after devaluation of existing shares returns are still great for investors. HELOCs are probably main play for small fish but big players are funded by proper investors.

This particular lender is issuing more than $1B in loans/year and have condo developers as customers, not only desperate homeowners. Why developers go to private lenders? That I don’t know but I know for a fact that they use private lenders as main financing facilities.

Good analogy. Agreed, this is no longer about a bunch of leveraged pigs and possums; the effects will be felt across the country and in almost every community. I think we’ve just scratched the surface and it is already looking like a cesspool. Tick tock.

I posted this to the last article very, very late in the cycle, and many may have missed it, but I think it is worth repeating.

And an addendum follows, with some updated info.

This is rally, really scary stuff.

If it bears out, everything that has been stated herein about real estate trends in Canada is mute.

We are talking, not just about a stock market crash, but the complete collapse of the American economy. And this does not fall into the ‘don’t attribute to a conspiracy what can be explained by stupidity’ venue. it is cold, hard facts and figures. Real money.

I paraphrased many of the important points in the article, and I am re-posting them here.

The new info is from tps://www.cnbc.com/2018/07/02/corporate-buybacks-are-the-only-thing-keeping-the-stock-market-afloat.html

‘American corporations owe $6.3 TRILLION of debt, but have only $2.1 trillion in cash on hand, and only about 19 of 1,900 corporations have that money. And of those, only seven have the bulk of it.

‘That debt is one third of the entire GDP of America.

‘American companies are living and surviving on credit and cheap money, NOT on ‘good economic fundamentals’.

‘And they are using this credit to buy back their own stock, to pay out dividends, and to buy market share (other competitors).

‘If American corporations end up in a cash flow tightening, and if US interest rates keep going up, the bulk of American corporations are at severe risk of having their loans called, and in seeking bankruptcy protection.

‘This is not just the Big Three auto companies, like it was in the ‘great recession’, but almost EVERY major American corporation, [including EVERY big American bank].

‘And remember, when a company goes bankrupt, it’s stock value does not just drop, it disappears. The entire value is wiped out. Hundreds of billions of dollars of exuberant money, just vanishes.

‘And this when the US treasury is facing trillion dollar a year deficits.

‘Talk about being vulnerable to a credit crunch and interest rate increases.

This is the end of my previous post, and here is the new revelation, from tps://www.cnbc.com/2018/07/02/corporate-buybacks-are-the-only-thing-keeping-the-stock-market-afloat.htm .

‘Companies buying back their own shares is the only thing keeping the stock market afloat right now’

“Companies announced $433.6 billion in share repurchases during the period, nearly doubling the previous record of $242.1 billion in the first quarter, according to market research firm TrimTabs.

“Dow components Nike and Walgreens Boots Alliance led the most recent surge in buybacks, with $15 billion and $10 billion, respectively, last week. In all, 31 companies announced buybacks in excess of $1 billion during June.

“At the same time, investors dumped $23.7 billion in stock market-focused funds in June, also a new record. For the full quarter, the brutal June brought global net equity outflows to $20.2 billion, the worst performance since the third quarter of 2016, just before the presidential election. The selling is particularly acute in mutual funds, which saw $52.9 billion in outflows during the quarter and are typically more the purview of the retail side.”

The entire corporate America and the entire wealth of the American stock market is hanging by a thin thread of borrowed money, not a robust economy.

Good observation. The worst part of the stock buybacks are the Shiller P/E is near all-time highs. That means profitability isn’t improving with all of those buybacks, they’re just being used as a trigger to for comparative retail purchasing of stock.

Same concept for houses if you think about it. The comps are inflated by people with three mortgages, and you’re just going to make a purchase with your conservative, traditional 20% down mortgage. A correction blows out their leverage, which never gets paid back. It also take out your existing equity.

Like a ponzi or pyramid scheme, eventually the money source runs out and everything collapses. There is nothing left to prop the market up. The well has run dry, because there is nothing replenishing it. No manufacturing, no product sales. Just money making money.

As long as this money is never used to actually BUY anything tangible, the system works. But when there is not enough tangible things to match the available funny money, because nothing is actually being manufactured, what happens? The rich are super-rich, but there is nothing left for them to use their money to buy, except more money?

Oh, except for real estate and stocks. Is America at that point? Nothing available to buy, so the rich have to buy real estate at super-inflated prices, just so they can actually SPEND their wealth on something tangible other than money?

Thanks for sharing but this is not new. Read any of John Mauldin (not a plug) latest stuff. Mauldin does a deep dive into future liabilities (pensions, social security, etc.), it focuses on the U.S but is applicable for most of the western developed economies. Time bomb waiting to go off, thanks baby boomer for living longer…hehehe

Not sure what future liabilities has to do with corporate America completely abandoning America for greener pastures.

Actually, it does in a way.

Corporate America has completely abandoned the future. No investment in capital spending, no investment in productivity, no investment in infrastructure. The things that the future is built on, and the things that future liabilities will be paid from.

Buying back stock does absolutely nothing to the productivity, profitability, or strength of a company. Once initially sold, not a penny of any future sale is ever returned to the company.

If IBM stock price, for instance, dropped to zero, it would have zero effect on IBM’s income or sales.

But it WOULD have an effect on executive income, since a great portion is based on the stock price. As long as the stock price remained high, these executives would still earn gargantuan salaries, even if IBM sold not one thing.

It is the demise of America. Corporate boards are far more interested in the stock price than they are in the health of the company,

I’m shocked how the system works! And I always wonder why there’s no regulation in place for whoever is distorting the housing market. Maybe I’m dumb and don’t realize how the system works. I’ll keep researching though until I get to the reality.

I think the big question is why arent prices dropping yet? We have the policies in place, interest rates were already increased, sales are still down. How are these guys with multiple mortgages still managing them? Why wouldnt they atleast sell at their buying prize and just get out? why are they still looking for 2017 prices when they know the risks involved?

^ this. Prices correct when monetary contraction occurs, which happens as credit growth slows. We’ll need annual declines in real credit growth, which is when lenders start to tighten up lending requirements quickly. Then it’ll be more apparent to buyers, and increase liquidity.

Hi. Yes. Medium long time reader, first time commenter. I have a question. If everything here is true (and so we’re clear, I think it probably is) why isn’t everything falling apart like, right now? What’s actually keeping all this nonsense aloft?

Dumb money is slow to act. Steps to any asset are pretty much the same.

1 ) Institutional money and developers buy in, they have a long investment timeline and are really good at pricing property. They plan on selling to smart money.

2) Smart money flows in, they have a shorter timeline but are just before the pop. They are the liquidity for Stage 1. They plan on selling to traders/retail investors.

3) Traders (flippers)/Retail investors show up, and start buying. They have shorter timelines, usually buying the rest of the developments and institutional assets. This is the liquidity for stage 2, and any leftover Stage 1. They plan on selling to dumb money and mass market.

4) Dumb money, and mass market starts buying. They don’t know what their timelines are, they don’t understand their cost basis, and they don’t know who’s going to buy it from them. Usually they’re convinced there’s dumber money. There isn’t, they’re Wiley Coyote as they run off the cliff. You wait for them to realize they ran over the cliff.

Usually there’s a trigger that alerts their attention, but they have no other liquidity options anyway. People will blame foreign buyers/credit tightening/recessions/etc. But seriously, who was the person that paid 30% more, at a 15% interest rate planning on selling to?

This site had a great article on Toronto housing as an asset cycle a while back. It was helpful for me.

On a side note Moody’s analytics just released their most recent 5 year outlook. It doesn’t look that bad even the Ontario one (kinda flat). Like I mentioned before I am not computer savvy so please google it and you’ll find it. Will it come true? I don’t know I guess we will have to wait for 5 years and compare the results.

Oh Willy, how do you need to be computer savvy to post a link? I will be nice. You did this before in May, with some sort of investor site, which you couldn’t link to, saying everything is fine. I view this as subversive and someone may actually believe this to be true if they took it at face value. I haven’t read anything, even in the ass-end of the intraweb, suggesting we’ll be fine. All the vultures are circling; the next big opportunity is profiting off of misery. Distressed debt. Shorting anything.

To add some Blue to this: Moody’s, the same rating agency that in 2008 was certifying repackaged debt as AA+ when it was barely Junk….that rating agency? Had to pay a fine because they were complicit in the crash. That moody’s?

And that’s why I said we have to wait for five years to see the results which may or may not materialize. I am not saying I agree with their forecast just saying here is a piece of research guys and asking you if you agree or not. Yes I read about that thing before the RE crash in US and at the time they were wrong and again that’s why I ask other people’s opinion because I don’t believe everything just blindly.

There was a good article (for once!) in The Economist a while back “A Mean Feat” which tracked a large number of economic forecasts over time and concluded they were mostly worthless. Takeaway:

“Forecasts of all sorts are especially bad at predicting downturns. Over the period [studied], there were 220 instances in which an economy grew in one year before shrinking in the next. In its April forecasts the IMF never once foresaw the contraction looming in the next year. Even in October of the year in question, the IMF predicted that a recession had begun only half the time. To be fair, an average-growth prediction also misses 100% of recessions. One model does better, though. Our random-number generator correctly forecast the start of a recession 18% of the time.”

The lenders that followed after the first likely wouldn’t get anything. They most likely lent based on redevelopment of the property, which a traditional lender would not have. I’m guessing the high interest rate contributed to it Dwelling to such a size, but even still it’s a lot of leverage for that home.

Good catch. Except that in a hypothetical scenario, it is almost zero cents cost on the dollar, except for closing costs. Complete conversion. The original legitimate mortgage holder gets their money, the second lender gets rid of $7 million dollars.

Lend an over-leveraged seven million to a compatriot, in an over-leveraged transaction. The original 3 million is all clean, the actual value of the house, so the original legit lender is covered. Clean money in, clean money out. Your compatriot now has seven million of ‘clean’ money (the original 3 million goes back to the bank). This clean money now gets spent, with a clear, clean legit paper trail back to the original over-leveraged mortgage. Use it to buy more property. A clean transaction. You have a clear trail for where the money came from. A clean loan.

The ‘lender’ appears to be out the seven million, but in a paper trail only. The compatriot has it. It is not lost money. The ‘lender’ does not bother to pursue the defaulting mortgagee, by pursuing the properties that were purchased with the money.

Since the ‘lender’ no longer has the money, nothing for authorities to pursue. Who cares where the money came from, if it is no longer in the control of the lender? The ‘income’ is perfectly balanced by the loss. Nothing further to account for. As far as the CRA is concerned, case closed.

From the lender’s perspective, the money essentially does not exist. Yet the compatriot has the tangible goods. Income tax free, I might add, because loans are not taxable income. The mortgagee earned no income.

This is exactly what the G&M exposed a month ago. Putting our financial institutions/lenders on the hook while they clean money and then use elsewhere. I think the banks were happy to oblige until there risk was too high but private lenders were always in the shadows. Once the banks stopped lending, the only game in town was private/community. Something is rotten in the state of Denmark. If this doesn’t implode within the next 6 months, I’ll be shocked because someone has to be on the hook for $7M+ and this is ONLY one example. Have to shout out to Vancouver; I assume what is happening in ON is 10x worse out there. Shit slurry. BD4L.

It’s actually a bloodbath. Many unsophisticated privates are begging bigger ones to come in and salvage the disasters they find themselves in. Just take a quick drive up to Innisfill. There are so many houses for sale it looks like an election with everyone having a sign on their lawn. The only pockets that will not get decimated are areas with real wealth. But thats a fraction of the action. Prepare to see home prices begin to plummet by September.

If a Roman division attempted a mutiny against Rome, every tenth soldier was randomly selected and killed viciously and publicly. The ranks were ‘decimated’ – deci- as in ten. It was effective at quenching a mutiny without causing a disastrous reduction in manpower.

I will rephrase: the only pockets of real estate that won’t get destroyed are areas with serious wealth such as ultra luxury condos penthouses where owners are billionaires. Or streets such as Dunvegan or Warren Road where the richest people in the country reside. Aside from the outliers, most neighborhoods are seeing prices drop and homes sitting longer and longer. Even CP24 is seeing way less mortgage advertising. As the summer moves along, tough decisions will need to made and the bloodbath will turn nastier as peopla desperately rush to sell before the winter snow.